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The most important piece in a behavioral health business sale

May 14, 2014
by Shannon Brys, Associate Editor
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Part 2 of 3

[Read Part 1]

After the decision has been made to sell the behavioral health organization, owners can streamline the process. Kevin Taggart, co-founder and managing partner at Mertz Taggart (Johns Creek, Ga.), a healthcare merger and acquisition firm with an emphasis on behavioral healthcare, sold his healthcare company about five years ago and since then has been helping others sell their companies.

The first three steps of the process are what Taggart calls the “pre-process steps.” The first step is to prepare for the sale, and focuses on the organizational finances. They need to be cleaned up for a minimum of three years plus an interim for the current year and be available to the buyer(s). This includes the owner’s salaries and benefits. Personal items should be clearly identified and removed. Additionally, all reported should be updated and should clearly state:

  • Accounts receivable aging
  • Revenue by payer source
  • Revenue by service line
  • Laboratory revenue as a percentage of total revenue

“The quality of the financial statements and management of reports is the buyer’s first impression of your company,” explains Taggart. “This goes directly to trust.”

If the plan is for the owner to sell the organization without future involvement, the deal is more attractive if some of the second level management remains for continuity.

The second step is to evaluate the business. The best time to sell an organization is when it is growing. At this point, the market will determine the price.

While some owners ask a certified public accountant (CPA) for advice on the purchase price, CPAs often have a different goal in mind, says Taggart. “They are trying to minimize your tax liability and they may not know what the market is for a behavioral healthcare company.”

Typical valuations may be based on one or more of the following:

  • Discounted cash flow: Projected future free cash flows minus discounts equal present value.
  • Multiple of adjusted EBITDA (earnings before taxes, interest taxes, depreciation and amortization)
  • Percentage of revenue in the current market
  • Market rate
  • Combination of the above methods

Terms of the deal

When it comes to evaluating the business and the sale options, the terms can be as important as the price, says Taggart. Terms to consider are:

  • “All cash.” In the behavioral health sector, typically 75 to 80 percent of the purchase price is paid in cash.
  • Owner financing
  • Earnout
  • Non-compete clause
  • Working capital

Working capital is “typically the most contentious item discussed between buyers and sellers,” Taggart says. While some buyers allow the seller to keep the working capital, many want all or a portion of that to come with the purchase. Many buyers view this as a piece of the property they purchased, while many sellers believe that they earned it and it is theirs to keep.

Weighing the options

In the third step of the selling process, it’s all about weighing the options. The “team” is formed and typically consists of an attorney, CPA or tax advisor, intermediary, and invested parties.

Sellers can expect to wrestle with terms unique to selling a business. These include:

  • Exclusive engagement agreement, in which the intermediary receives a fee upon completion of the sale.
  • Non-exclusive agreements have no fee provisions for the intermediary and typically take longer to complete.
  • Tail periods protect the intermediary for the client listing.

Commitment to the process

Here, it’s crucial for the seller to keep the sale confidential and maintain focus on the business. Taggart says many times sellers are simply tired and let the business get sloppy – and severely damage the evaluation.

At this point, a profile is created that typically consists of an eight to ten page narrative followed by 40 to 50 pages of financial information. It will contain all business-related licenses and certifications; facility information and history; corporate structure and ownership; sales and marketing activities; as well as business advantages such as specialized or clinical programs.

Taggart’s rule for creating the profile is balance: Only the necessary. For example, although one of the first things a buyer asks is the reason for the sale, Taggart recommends against including it in the profile. Nor should the price or the terms be included. If the price is too high, good buyers may be scared away and if the price is too low, the owner is “leaving money on the table,” he explains.

In part three of the series, Taggart explains the rest of the process from identifying the best buyers, to what happens after the transaction is complete.

[Continue to Part Three]

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